Contextualizing Herbalife (HLF) and its peers within the history of multi-level marketing

What is the likelihood that the FTC will take significant action against HLF?

If in fact HLF is a pyramid scheme, as Ackman claims, how long can it continue its growth pattern before collapsing?

ABOUT DR. JON M. TAYLOR

Dr. Taylor has dedicated a majority of his career to researching multi-level marketing (MLM) and its impact on consumers. He has authored books and numerous analytical reports on profitability, viability, ethics and abuses of "product-based pyramid schemes" including The Network Marketing Game and The Case (for and) Against Multi-level Marketing. Through his research Dr. Taylor developed tools for evaluating MLMs and their profitability (or lack thereof).

His Five-step Do-it-Yourself Evaluation of MLM Programs is an interactive program for visitors to his website - www.mlm-thetruth.com. His research has been confirmed by the analysis of over 400 MLMs and feedback from thousands of consumers. Dr. Taylor received an MBA degree from BYU and a Ph.D. in Applied Psychology from the University of Utah. He is currently President of the Consumer Awareness Institute and President of the Jon Taylor & Co., Inc.

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01/31/13 12:09 PM EST

THOUGHTS ON EARNINGS SEASON

Below is a quick account of our stance on restaurant stocks reporting earnings over the next three weeks.

2/4 – YUM is the worst performing QSR stock YTD, underperforming the S&P 500 by over 700 bps. The concerns about business trends in China are pervasive and not helping business trends in China. We believe that the company has made amends with the Chinese government and are past the issues that have plagued the share price. The US business is strong and we would be long going into the quarter. Expectations have been bombed out and the company is likely to be aggressive in using its balance sheet and cash flow to buy back stock in 2013.

2/5 – CMG has underperformed the market by 200 bps YTD. The stock has rallied recently on the hope that the company’s pricing strategy will save the day. We think it is unlikely that the company has pricing power. Recent menu introductions and testing suggest to us that the company is struggling to stay top-of-mind with consumers. We are bearish, and would be short, ahead of the quarter.

2/5 – PNRA is a name we want to like but it is difficult to get comfortable at this price. Panera is the second worst performing QSR stock, year-to-date, underperforming the S&P 500 by almost 500 basis points. We published on this stock yesterday and our macro team’s quantitative analysis indicates that the share price is in a negative formation.

2/6 - GMCR is a stock that we do not have a high degree of conviction on but retain a bearish bias due to our concerns about the sustainability of the business model. The new CEO’s articulation of his vision for the company’s future will be important for our view on the stock going forward.

2/7 – BLMN is a stock being supported by high expectations. Outperforming the market by over 1,200 bps year-to-date, BLMN has little upside heading into earnings, in our view. We would not pay a premium for 6% revenue growth and 8% earnings growth in FY13. The lack of leverage in the business model, compounded by the casual dining price wars and red meat inflation, is a red flag for us. If we had to take a position, we would be short heading into the quarter. PE firms will be unloading their shares soon!

2/12 – BWLD is our favorite short in the group. Its shares have underperformed by more than 450 bps year-to-date but we believe that 2013 will be a difficult year for Buffalo Wild Wings.

2/15 –DPZ is facing a very challenging 4Q SRS compare, but is one of the few restaurant companies that does not face a difficult comp in 1Q13. The headlines from the 4Q12 press release could pressure the stock price but we would be buyers on weakness.

2/15 –BKW has outperformed the S&P 500 by 320bps YTD. To some degree, BKW has benefited from MCD’s trends decelerating but there is little in BKW’s strategy, that we know of, that gives us confidence in the sustainability of current top-line trends. Same-restaurant sales in 4Q12 will likely look strong but we don’t expect subsequent quarters to impress from a headline perspective. We would be looking to short this name following 4Q12 earnings.

2/15 – BJRI reported 4Q12 same-restaurant sales of 3% during the ICR conference. Much of the impact has already been taken out of the upcoming release. Chili’s has launched pizza nationally and is looking to heavily promote this item for the balance of the fiscal year. We continue to believe that a resurgent Chili’s is negatively impacting BJ’s business. We are awaiting an entry point to short BJRI.

2/18 – JACK is still an attractive to investors looking for a longer-term story. The stock has underperformed the market by over 400 bps year-to-date but we believe the upside remains greatly underappreciated. We are buyers on weakness.

2/20 – CAKE will likely report 4Q12 results in line with expectations. We see risk to guidance for 1H13 versus expectations as the Street is modeling significant margin expansion in the face of dairy prices running far ahead of year-ago prices.

2/21 – TXRH has underperformed the S&P 500 by 150 bps YTD. We would steer clear of this stock on the long side, given difficult compares during 2013 and the likelihood of higher red meat impacting margins.

Howard Penney

Managing Director

Rory Green

Senior Analyst

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01/31/13 11:27 AM EST

DOJ Sues to Block Anheuser-Busch InBev's Acquisition of Modelo

Moments ago, the Department of Justice filed suit in Federal Court to block Anheuser-Busch InBev's (ABI) purchase of Grupo Modelo. Constellation Brands (STZ) has moved precipitously lower on the news.

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We view the decision to go to litigation as part of the dance, although admittedly an aggressive move. While aggressive, it is certainly not the end of the process. For some perspective, the DOJ also filed suit to block ABI’s purchase of BUD. It isn’t an uncommon step in the more contentious mergers, but while this certainly represents a delay in the closing of the transaction (no longer Q1), it does not mean that the transaction will not close.

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The parties will now move to litigation or, alternatively, additional concessions can be made by ABI to satisfy the concerns expressed by the DOJ in the complaint.

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Our view remains consistent – this transaction represents significant value to ABI, and therefore we believe that additional concessions are very likely.

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While the move down is painful, we continue to see substantial value to Constellation Brands should the transaction close, an event that we continue to see as likely, though delayed.

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01/31/13 11:24 AM EST

WILL BRAZIL HOLD THE LINE?

Takeaway:Watch Brazil closely here. A TREND-line breakdown is likely a very dour signal for the Brazilian economy and other risk assets broadly.

SUMMARY BULLETS:

All told, if the Bovespa holds its TREND line here, we are looking to use the recent weakness as an opportunity to increase our allocation to Brazil on the long side of equities and the BRL.

If the index breaks down, however, that would be a signal to us that our bullish fundamental bias on Brazil is not yet a probable outcome and we’d suspend that view until further notice.

Additionally, the aforementioned breakdown would likely be a leading indicator for weakness across risk assets broadly over at least the next few weeks. Our analysis of previous cycles and the key drivers of the Brazilian economy is supportive of this conclusion.

WHAT NOW?

Brazil’s benchmark Bovespa Index is literally dancing on its TREND line right now; if it holds, we’re buyers. If it snaps, that’s likely a very bad leading indicator for “risk assets” globally. We hate using that colloquialism, as every asset holds some degree of risk (like US Treasury bonds in the YTD; are those also risk assets?), but it works for now.

To quickly recap why we’re bullish on Brazilian equities – particularly the consumer and industrials names – we think the combination of continued currency appreciation will help promote domestic purchasing power and inflows of international capital, on the margin, and historically-low interest rates will reinforce penned-up demand for capital outlays (World Cup and Olympic Games preparations are generally well behind schedule).

It helps that Brazil’s non-seasonally adjusted unemployment rate also just ticked down to a record low on a monthly basis (DEC) and on an average annual basis (2012).

On the bearish side of the ledger (there’s always disconfirming evidence in Global Macro research; you just have to figure the appropriate weight to assign to it in your fundamental reasoning), inflation continues to be a major headwind to Brazilian economic activity and with the recent strength in global commodity prices, inflationary pressures continue to bubble up in Brazil.

That’s why we continue to anticipate outsized gains in the Brazilian real over the intermediate term. Because President Rousseff has all but officially prohibited the central bank from hiking interest rates, Brazil must reverse course on capital controls and allow its currency to strengthen dramatically, or the inflation monster will strike the final nail into the coffin of Brazil’s once-ballyhooed “BRIC” status.

Make no mistake, Brazil’s recent spate of Big Government Intervention has threatened to make investing in Brazil a structurally taboo activity. On the strength of continued investor-friendly reforms (like the recent gasoline and diesel price hikes for PBR), however, we’re anticipating a revival in international investor sentiment towards Brazil in 2013, but are necessarily married to the idea. Rousseff and Mantega need to deliver.

For more details behind our bullish bias on Brazilian equities (TREND), please refer to the following two research notes:

On 10/24, we published a note titled, “IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS?” in which we forewarned of pending weakness across “risk assets” across the Global Macro universe. From the publication of that note to the 11/15 bottom in the SPX, the following price deltas were recorded:

S&P 500: -3.9%

MSCI World Index: -3.5%

CRB Index: -1.6%

JPM EM FX Index: -1.2%

RWR (SPDR REIT etf): -3.9%

US Junk Bond YTM (FINRA-BLP Index): +44bps

As detailed in the aforementioned note, we find merit in using Brazil as a stealth, short-cycle leading Global Macro indicator because, since late 2008, the Bovespa Index has generally led global equities on nearly every major intra-cycle rally and correction.

Specifically, we think Brazil’s unique setup from a capital markets and economic perspective exposes it to getting pulled aggressively in both directions of global inflation expectations (reflation and de/dis-inflation).

On the way up, the Bovespa Index is heavily weighted to reflation with 65.7% of its market cap having direct exposure to top line and margin leverage that stems from rising prices of commodities and risk assets (Energy, Basic Materials and Financials sectors).

On the way down, the Brazilian economy is heavily weighted towards domestic consumption, so the tailwind of disinflation and/or falling inflation expectations tends to become a demonstrable tailwind for Brazil’s growth outlook and supportive of speculation around easier monetary and fiscal policy in Brazil. It’s worth noting that consumption accounts for 81% of Brazil’s GDP by expenditure (household = 60.3%; government = 20.7%).

All told, if the Bovespa holds its TREND line here, we are looking to increase our allocation to Brazil on the long side of equities and the BRL. If the index breaks down, however, that would be a signal to us that our bullish fundamental bias on Brazil is not yet a probable outcome and we’d suspend that view until further notice.

Additionally, the aforementioned breakdown would likely be a leading indicator for weakness across risk assets broadly over at least the next few weeks. Our analysis of previous cycles and the key drivers of the Brazilian economy is supportive of this conclusion.

Darius Dale

Senior Analyst

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01/31/13 11:13 AM EST

PENN 4Q12 REPORT CARD

In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance

OVERALL

WORSE: Tough quarter and guidance. 2013 guidance does look aggressive to us but the reality is that even on our 2013 estimates, we estimate there is more value to PENN post-REIT conversion than the current value of the stock.

TOLEDO & COLUMBUS

WORSE: Ramp in slot volumes has been slower than anticipated, leading to a reduction in 2013 EBITDA guidance. PENN sees Columbus slot volumes to improve sequentially in January.

PREVIOUSLY: “We have over 200,000 accounts signed up in Toledo since we've opened and we're still very encouraged about the prospects as we move into 2013 there. “We're right now very pleased with the flow-through coming out of Toledo and expect similar kind of results in Columbus as that property now is – today is day 10. The early results in Columbus are very much in line with what we would expect in a market of that size.”

OVERALL BUSINESS TRENDS

WORSE: PENN is seeing the lower end consumers taking fewer trips. Ohio is underperforming expectations. Gulf Coast market also has been under pressure.

PREVIOUSLY: “I characterize our businesses that have not been impacted by new supply as generally flat. We're seeing visitation trends year-over-year flat and spend per visit generally flat in markets that are stable. Really not seeing anything different than what we saw in the second quarter.”

“Toledo is doing a little bit better than we thought and I think Charles Town is doing a little bit better than we thought and then there's some offsets to both of those in different markets across the United States. Clearly, the – I call it the Gulf Coast area is a bit challenging, and clearly not exactly as healthy as we would hope, but that's obviously – those are relatively small properties.”

2013 BUSINESS OUTLOOK

WORSE: EBITDA guidance was lowered to reflect a very challenging demand environment. PENN is also seeing more volatile market conditions.

PREVIOUSLY: 2013 outlook: “I think the initial feedback is most people seem to think that we're in a pretty stable environment, nobody is projecting or feels comfortable that we're going to get a hockey-stick recovery, nor do they feel like we're going to see any kind of significant downturn… Our thinking too, as we go into the fourth quarter and into next year that the promotional environment is going to be – going to remain stable”

PROGRESS ON REIT CONVERSION

SAME: PENN received a Private Letter Ruling from the IRS relating to the tax treatment of the separation and the qualification of PropCo as a REIT.

PREVIOUSLY: “We are effectively finished with the IRS. That doesn't mean that some facts and circumstances couldn't change that might require us to go back, and I have to say that for attorney's purposes, but for all intents and purposes relative to the IRS, we're finished. We just need to get our gaming approval and get some financing done to obviously accommodate the spin.”

MARYLAND LOBBYING EXPENSES

WORSE: $26 million is $2 million higher than PENN's November guidance.

PREVIOUSLY:

Q: “Is the Marlyand lobbying expense projection in your EBITDA guidance for the balance of this year”

A: “No, the amounts that we're spending in Maryland are decisions made on the day-to-day basis as the tactics of the campaign unfold. And so, therefore, what we are not doing is trying to project exactly how much we're going to spend, nor do we want to forecast how much we're going to spend for obvious strategic reasons”

“Just to be clear on the $20 million lobbying that is in your current guidance, but the $11 million October to-date and whatever you go above that is not in the guidance? Correct”

PREVIOUSLY: “I would generally say, so far so good, slightly less than we expected, but there's a lot more that has to evolve before we can make any conclusions on what our new business volumes will be at our Hollywood Baton Rouge property”

OHIO RACETRACK UPDATE

SAME: Dayton and Austintown racetracks on track for 2014 opening.

PREVIOUSLY: ““We are waiting for the approvals from the lottery and racing commissions to relocate our tracks. We need to get that before we get this started, hopefully, that'll occur before the end of the year. We hope to break ground end of the year, early 2013, and we're talking about a first half of 2014 opening, if all goes well right now.”

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01/31/13 11:07 AM EST

JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN?

Takeaway:Don't believe what you read. While claims appeared to deteriorate significantly WoW, they actually improved slightly. Here's why.

A Quick Walk Through What's Really Happening & What the Market Thinks is Happening ...

Let's start with the perception of what's happening. The perception is that initial jobless claims rose 38k to 368k from 330k WoW. This is being regarded as bad, which is not a surprise. First, let's put this morning's headline number in context. As we flagged two weeks ago, we're simply seeing the reversal of very poorly adjusted number from two weeks prior. Two weeks ago claims dropped by 37k, their largest one week drop since the same week last year. Last year's drop of 46k was followed by a 23k bounce, which was in turn followed by a 4-week drop of 20-25k. This year, we saw claims drop 37k two weeks ago, drop a further 5k last week and this morning rise by 38k. In other words, we're right back where we started 3 weeks ago; actually, we're still 4k lower.

Initial claims should trend steadily lower from here over the next four weeks as the final phase of Lehman's Ghost kicks into the seasonal adjustment factors. Thereafter, beginning in March, we'll begin to see the strength in the labor market cool off, and ultimately give way to weakness as April progresses to August.

Now, let's take a look at what's really happening. Rolling NSA claims improved year-over-year by -4.8% this week, that's an improvement vs. the prior week's -4.3% change. This may not sound significant, but it is because it marks an inflection from what had been two straight weeks of deterioration. Remember that a more negative number is better, as we're measuring the YoY change in jobless claims.

This series has consistently been the best read on the underlying labor market condition. Bear in mind that tomorrow's payroll report suffers from the same seasonality problems as jobless claims. Tomorrow's report, by the way, should be very solid (partly because it's benefiting from an imaginary tailwind).

Given this dynamic, we continue to expect Financials to push higher through February and likely into March (high beta, value names continuing to lead the way), though as the labor data cools in March/April we expect to see the same pullback we've seen over the last three years. However, we think this year's pullback will be smaller than in years past, partly because Lehman's effect is shrinking, but also because the housing data should partially offset the perception of weakening labor dynamics.

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